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3d 357
James R. Malone, Jr., with whom C. Oliver Burt, III, Michael D. Gottsch,
Pamela Bond, Haverford, PA, and Peter A. Pease, Boston, MA, were on
brief, for appellants.
Robert Upton, II, with whom Charles W. Grau, Concord, NH, was on
brief, for Amoskeag Bank Shares, Inc.
Ovide M. Lamontagne, with whom E. Donald Dufresne, Manchester, NH,
was on brief, for Allen, Machinist, Bushnell, Yakovakis, Woolson,
Allman and Keegan.
Before TORRUELLA, Circuit Judge, COFFIN, Senior Circuit Judge, and
BOUDIN, Circuit Judge.
COFFIN, Senior Circuit Judge.
During the period relevant to this litigation, defendant Amoskeag Bank Shares
("Bank Shares" or "the bank" or "the company") was a New Hampshire bank
holding corporation with four wholly owned subsidiaries: Amoskeag Bank,
New Hampshire's largest bank; Nashua Trust Company; Bank Meridian, N.A.;
and Souhegan National Bank of Milford.1 The seven individual defendants are
certain of Bank Shares' former officers and/or directors.
Plaintiffs are the purchasers of Bank Shares' common stock. In this lawsuit,
filed as a class action but still uncertified, they claim that the defendants issued
various documents, reports, and statements that misrepresented and failed to
disclose material facts concerning Bank Shares' true financial condition,
thereby artificially inflating the market price of the company's stock at the time
they purchased it.2
The complaint depicts an increasingly familiar saga of a bank that boomed with
the real estate market of the early 1980s, but suffered in the recession and
deteriorating market that followed. See, e.g., In Re Wells Fargo Securities
Litigation, 12 F.3d 922 (9th Cir.1993); In Re Glenfed, Inc. Securities
Litigation, 11 F.3d 843 (9th Cir.1993), reh'ng en banc, granted, 11 F.3d 843
(9th Cir. Feb. 25, 1994); Shapiro v. UJB Financial Corp., 964 F.2d 272 (3d
Cir.1992); DiLeo v. Ernst & Young, 901 F.2d 624 (7th Cir.1990). The primary
thrust of the allegations is that defendants knew that their loan portfolio
contained many high-risk loans, that the reserves for such loans were
inadequate,3 and that poor internal controls exacerbated the difficulties, but that
they nevertheless continued to paint a rosy picture of the bank's financial
circumstances.
The district court, having given plaintiffs the opportunity to amend a previous
version of the complaint, concluded that, "[a]t most, the [Third Amended]
[C]omplaint demonstrates dubious business judgment or mismanagement." The
court felt that the pleading, reduced to its essence, alleged that the defendants
throughout the relevant period knowingly reserved too little in anticipation of
loan losses. In the court's view, however, the complaint lacked a basis for
inferring the defendants' knowledge of the deficiency and, moreover, failed to
identify any specific loans whose reserves were inadequate. These deficiencies,
despite ample opportunity for discovery and "considerable ingenuity in
pleading," prompted the court to dismiss the complaint with prejudice.
Plaintiffs argue on appeal that the complaint more than adequately set forth the
bases for their allegations of fraud by detailing numerous specific instances in
which the defendants had knowledge of the "true facts," yet made substantially
different representations to the investing public. They claim that the district
court impermissibly drew inferences in favor of the defendants, contrary to its
obligation to indulge every reasonable inference helpful to their case. See, e.g.,
Garita Hotel Ltd. Partnership v. Ponce Federal Bank, 958 F.2d 15, 17 (1st
Cir.1992).
We review the district court's determination de novo, applying the same criteria
employed by the district court. Id. If the allegations would permit recovery
under any viable theory, the dismissal must be reversed. Id.
We preface our discussion with a brief survey of the general principles that
must guide our review of plaintiffs' complaint. First, the securities laws "do not
guarantee sound business practices and do not protect investors against
reverses," DiLeo, 901 F.2d at 627. In stating an actionable claim for
misrepresentation, therefore, plaintiffs must plead more than that defendants
acted irresponsibly and unwisely, but that they were aware that
"mismanagement had occurred and made a material public statement about the
state of corporate affairs inconsistent with the existence of the
mismanagement," Hayes v. Gross, 982 F.2d 104, 106 (3d Cir.1992). See also
Shapiro, 964 F.2d at 283 ("[I]t is not a violation of the securities laws to simply
fail to provide adequate loan loss reserves; properly collateralize or secure a
loan portfolio; or provide sufficient internal controls or loan management
practices.").
Second, defendants may not be held liable under the securities laws for accurate
reports of past successes, even if present circumstances are less rosy, see Capri
Optics Profit Sharing v. Digital Equipment, 950 F.2d 5, 7-8 (1st Cir.1991),4 and
optimistic predictions about the future that prove to be off the mark likewise
are immunized unless plaintiffs meet their burden of demonstrating intentional
deception, see Greenstone v. Cambex Corp., 975 F.2d 22, 25-26 (1st Cir.1992)
(there is no " 'fraud by hindsight' "); DiLeo, 901 F.2d at 627 (same). See also
Shapiro, 964 F.2d at 283-84 n. 12 (quarterly report stating that the company
"looks to the future with great optimism ... is clearly inactionable puffing").
10
Fed.R.Civ.P. 9(b), the complaint must set forth "specific facts that make it
reasonable to believe that defendant[s] knew that a statement was materially
false or misleading." Id. The rule requires that the particular " 'times, dates,
places or other details of [the] alleged fraudulent involvement' " of the actors be
alleged. In re Glenfed, 11 F.3d at 847-48 (citation omitted). See also Romani v.
Shearson Lehman Hutton, 929 F.2d 875, 878 (1st Cir.1991); New England Data
Services v. Becher, 829 F.2d 286, 288 (1st Cir.1987) ("[I]n the securities
context, and in general, this circuit has strictly applied Rule 9(b).").
11
III.
12
13
14
These paragraphs describe Bank Shares' substantial losses in June and July
1987 when it sold certain mortgage backed securities, as well as stock that it
unlawfully held in eight banking companies. Plaintiffs allege that, with the
These paragraphs allege that, at the end of the second quarter of 1987,
defendants reversed an allocation of $275,000 that had been made earlier in the
year to its loan loss provision "for no reason other than arbitrary manipulation"
designed "to offset the impact of other losses." Plaintiffs claim that defendants
falsely represented in their Form 10-Q for the quarter that the decrease was
attributable to the credit quality of the bank's loan portfolio.
20
21
quantify possible losses inherent in its loan portfolio. The complaint alleges:
22
[C]ontrary
to public representations, by February 1988, the defendants had
determined that the existing loan review function was unable to keep up with timely
reviews of the Company's loan portfolios (which were known by defendants to be
deteriorating in creditworthiness due to changes in the economy) and the Company
lacked sufficient loan credit file documentation to properly analyze the ALL. Thus,
the Company hired a retired career banker, J. Howard "Mac" McGloon, on a
consulting basis to review lending practices and ostensibly to assist the Loan
Review department in its function.
23
p 34.
24
25
Although pp 40-42 allege that, during early 1988, defendants failed to follow
internal policy for recognizing earnings on commercial real estate loans and to
allocate the appropriate ALL amount for such loans, the complaint does not
demonstrate how these flaws in procedure add up to a securities violation. As
noted earlier, "mere failure to provide adequate reserves (or to perform
competently other management tasks) does not implicate the concerns of the
federal securities laws and is not normally actionable," Shapiro, 964 F.2d at
281.
26
Plaintiffs additionally complain about the tone of a press release issued by the
company on July 14, and the company's quarterly report filed with the SEC on
August 12. These reports were misleadingly positive, plaintiffs allege, because
they stated that earnings were down in part because of an increase in loan
reserves designed as a "safeguard against an extended slowdown in real estate
and condominium markets." See p 43. There is nothing actionable in these
statements, which simply report the company's reduced earnings and one of the
reasons for it.
27
Chaston
finds "serious deficiencies"; internal concerns; "conservative" approach, pp
46-69.
28
29
30
31
Defendants
Machinist and Allen made the following false and misleading statements
in the press release with respect to the increase in loan loss provision:
.....
32
33 have experienced a build-up of non-performing loans to $47 million, or 2.7
[W]e
percent of total loans, from $35 million at June 20, 1988, the majority of which
relates to commercial real estate. Our loan review capabilities are strong and we
have directed specific resources to each of those loans.
34
35
36
p 56 (emphasis added).
42
While non-accrual loans rose in the fourth quarter, from $26.6 million to $35.8
million, the rate of increase in problem loans has moderated. We are managing
those loans intensively and with success.
43
The real estate market is turning around slowly and further reductions of excess
inventory have been realized. Our policy of reserving conservatively in advance
of need is being validated. We remain well secured and confident of the values
underlying our loans.
44
45
46
Id. See also In Re Wells Fargo, 12 F.3d at 930; Hayes, 982 F.2d at 106-07.
49
50
approach may depend, inter alia, on whether company officials in good faith
believed their allocations were adequate, and considered the increases
recommended by the consultants to be "ultra" conservative, and thus excessive.
See In Re Wells Fargo, 12 F.3d at 927 ("[T]he setting of loan loss reserves is,
by all accounts, an 'art and not a science'...."). The precise timing of certain
statements in relation to the bank's ALL activity also is crucial.12
51
Similarly, the contested statements regarding the quality of Bank Shares' loan
management capabilities may turn out to be neither material nor misleading if,
for example, hiring consultants is a typical strategy of aggressive bank
managers to prevent more serious problems. In other words, defendants may
show that, in the banking context, "effective" loan monitoring often includes
adding hired experts to the company's own internal procedures.
52
We note, as an additional caveat to the court and the parties, that not every
paragraph in this section of the complaint contains actionable allegations,13 and
even those paragraphs that cannot be dismissed in their entirety as a matter of
law may contain allegations and wholly conclusory statements that warrant no
further attention.14 Although we leave to the district court's discretion how it
chooses to proceed upon remand, we suspect that it may wish to direct
plaintiffs to submit a revised, limited complaint consistent with this decision
before conducting further proceedings. Cf. Shapiro, 964 F.2d at 284 (directing
plaintiffs to reorganize complaint on remand to facilitate evaluation).15
55
satisfied by general averment that "defendants 'knew' earlier what later turned
out badly"). See also supra at 361. Unlike the earlier section of the complaint,
detailing the basis for the alleged inconsistency between defendants' knowledge
and their public statements, there are no facts stated here with any particularity
from which an inference of fraud reasonably can be drawn.
56
The complaint instead states that bank examiners in May reported the need for
an increased ALL, see p 73, that Bank Shares at approximately that time
obtained an extension for filing its first quarter report for 1989 so that it could
readdress the adequacy of its ALL, see p 75, and that it shortly thereafter made
a substantial increase, see p 76. From all that appears, Bank Shares acted
properly in doing what it was advised to do, while reporting accurately that it
was taking these steps because of "real estate related loan problems," see p 79.16
57
IV.
58
59
We conclude that, with respect to five of the seven defendants, the complaint
alleges a sufficiently specific connection to certain of the challenged statements
that dismissal of plaintiffs' claims as a matter of law is inappropriate. With the
exception of Bushnell and Woolson, all of the defendants are alleged to have
signed the 1988 Annual Report in which Bank Shares' loan loss reserves were
depicted as "sufficient" and "prudent," see supra at 364-65; Complaint, at p
64,17 and also are alleged to have received copies of the internal auditor's report
concluding that additions to the reserves were required as soon as possible,
Complaint, at p 50-51, as well as Chaston's report in December 1988 stating
that the ALL was inadequate, id. at pp 59-61. The acceptance of responsibility
for the contents of the Annual Report, demonstrated by defendants' signatures,
combined with specific allegations that they knew of conflicting conditions,
establishes a sufficient link between the defendants and the alleged fraud to
satisfy Rule 9(b)'s particularity requirement. Cf. Romani, 929 F.2d at 880 n. 4;
Wool v. Tandem Computers Inc., 818 F.2d 1433, 1440 (9th Cir.1987) ("In
cases of corporate fraud where the false or misleading information is conveyed
in ... annual reports ... or other 'group-published information,' it is reasonable to
presume that these are the collective actions of the officers.").18
60
Defendants Machinist and Allen are identified as the authors or speakers of the
other statements contained in the paragraphs that survive dismissal, and those
allegations also remain live against them. As to those statements, the other
defendants are alleged only to have authorized or acquiesced in them (the press
releases), or they are attributed no role at all in the dissemination of the
statements (remarks by Allen and Machinist at analysts meeting). See pp 52,
56. This is insufficient to meet the requirements of Rule 9(b).19
61
Defendants assert that the complaint fails in any respect to state an actionable
claim against the individual defendants because there are no allegations from
which scienter reasonably may be inferred, such as that they sold their personal
stock in Bank Shares during the class period. They argue that it is insufficient
to base a claim of fraudulent intent on allegations that defendants sought to
protect their compensation and prestige. See Complaint at p 105. See also
Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1068-69 (5th
Cir.1994).20
62
We agree that allegations that defendants committed fraud to save their salaries
or jobs ordinarily will not be enough to support a reasonable inference of
scienter if the complaint lacks any other basis for inferring fraudulent intent. In
this case, however, plaintiffs have done more than simply aver generally that
defendants knowingly misrepresented Bank Shares' circumstances, while
relying on a job-preservation motive to establish the element of scienter. As
described above, plaintiffs specifically cited reports and documents presented to
defendants at relevant times that were inconsistent with the defendants' public
statements. This satisfies the necessary pleading requirements. See In Re Wells
Fargo, 12 F.3d at 931 ("While 'allegation[s] of unusual insider trading by
defendants immediately preceding the disclosure of negative news' may be ... a
characteristic of a 'typical securities fraud class action,' they are not
required.").21
V.
63
We conclude that the plaintiffs have stated a claim against Bank Shares and
five of the individual defendants based on certain of the allegations contained in
paragraphs 46 to 69, with such limitations and exclusions as previously
described. To that extent, the dismissal of the Third Amended Complaint is
Rule 10b-5, promulgated by the SEC under the authority provided by Sec.
10(b) of the Securities Exchange Act, makes it unlawful to misrepresent or omit
material information in connection with the purchase or sale of securities
The amount put aside as a protection against loan defaults is known as the
ALL--the "allowance for loan losses."
Paragraph 32 quotes at length from the company's 1987 annual report and
suggests that its "decidedly upbeat" tone was fraudulent. Plaintiffs
acknowledge, however, that the bank disclosed the substantial drop in net
income from the prior year and the substantial loss in equity securities. No facts
suggest knowing falsity in any of the company's optimistic statements about its
future prospects
Similarly, plaintiffs fail to demonstrate any basis for inferring knowing falsity
in the defendants' statement, also quoted in p 37 of the complaint, that "the
Company's basic banking business is strong as indicated by the excellent
quality of the loan and lease financing portfolio."
This paragraph alleges that, on August 10, 1988, Bank Shares' vice president
and loan review officer Worden informed an Ernst & Whinney auditor that
the quality of commercial loans had deteriorated since E & W's last audit
review as of December 31, 1987, and that Worden did not believe that his
department was devoting an adequate amount of time to the monitoring of the
appropriateness of credit quality ratings assigned by Amoskeag's loan officers,
particularly in the area of CRE [commercial real estate] loans.
10
In p 69(d), plaintiffs allege that on about February 21, 1989, the company's
audit committee was told by its accounting firm, Ernst & Whinney, that a
Chaston report
"presented management and E & W with a problem" since Chaston had
concluded the allowances for loan loss at both Amoskeag and NTC were
inadequate by a combined total of $9.4 million. E & W further told the Audit
Committee it had been required to expend "significant effort in reviewing [a]
large number of individual loans to support adequacy of a reserve less than
Chaston felt was needed."
11
The complaint does not entirely lack reference to specific loans. For example,
in paragraphs 48 and 49, plaintiffs aver that, in meetings held on August 16,
1988, an Ernst & Whinney representative was told by the head of Amoskeag's
commercial real estate (CRE) division that certain CRE loans "were now
'maturing' and some were beginning to evidence signs of deterioration not
previously evident." p 48. The Amoskeag officer, Stephen Bradbury, noted in
particular residential condominiums, for which the bank had 18 or 19
outstanding loans. Additionally, plaintiffs allege that E & W learned from the
head of Amoskeag's private banking division of a number of large, unsecured
problem loans, three of which are specifically identified. p 49. The complaint
does not allege a connection, however, between these specific loans and the
asserted problems with internal monitoring and inadequate ALL
12
While a generous reading of the allegations in this section would permit the
inference that Bank Shares was representing its ALL as adequate and
"conservative" at the same time that it was receiving multiple reports that it was
not, it also is possible that some of the disputed statements occurred only in the
aftermath of corrective action--in particular, the $6 million allocation as of
September 30, 1988--and that bank officials thus reasonably believed that their
reports were accurate. For example, the review of Amoskeag's ALL performed
by the company's Internal Audit Department "[a]s of September 30, 1988"
indicated the need for "additional injections" to the ALL, but it is not clear
whether this assessment was based on the amount of reserves before or after the
$6 million was allocated retroactively to the third quarter. See p 50(b). Indeed,
it is necessary to determine whether Bank Shares in October 1988 viewed the
$6 million as a complete solution to the identified problems, or knew that it was
only a partial response to Chaston's initial findings, in order to evaluate its
public statements. See, e.g., pp 46, 54, 55, 57, 62
13
For example, p 61 states that defendants Allen, Yakovakis and Machinist were
"not surprise[d]" by Chaston's conclusion that the Amoskeag and NTC ALLS
were inadequate by a total of $12.1 million. The paragraph fails to identify with
the required particularity the conversations on which it is based, giving no
information about when and where these conversations supposedly took place.
Similarly, nothing in p 58, which addresses "below market rate" loans given to
condominium purchasers, gives rise to an inference of fraud, as distinguished
from simple mismanagement
14
In p 53, for example, plaintiffs allege that "defendants knew that the provision
for loan losses in prior periods had been arbitrarily understated without regard
to the requirement of the ALL, for the purposes of manipulating and artificially
increasing the Company's reported earnings." This language re-introduces the
allegations surrounding the 1987 decrease in the ALL, but it is no more
supportable at this point than it was earlier. See supra at 362
15
16
Plaintiffs point to a statement in Bank Shares' 10-Q for the second quarter of
1989, filed with the SEC on about August 1, explaining that the increase in the
provision for loan and lease losses "was the result of management's assessment
of the adequacy of the allowance for loan and lease losses in light of [the]
judgment that there has been significant deterioration in the condition of
problem loans since year-end," p 79. Nothing in the complaint suggests that this
was other than an accurate depiction of what occurred. That "management's
assessment" may have been affected by the views of examiners or consultants
does not make the statement a fraudulent misrepresentation. In asserting in p 80
that this statement was knowingly false and misleading, plaintiffs provide only
conclusory support lacking in particularity
17
The complaint alleges that Bushnell was chairman and chief executive officer
of Bank Shares until his resignation in early 1988, and he therefore was no
longer with the company when the 1988 Annual Report was written and
released. Indeed, because all of the actionable allegations concern the time
period after his departure, we affirm his dismissal from the case
Woolson is the only defendant not alleged to have been a director of Bank
Shares, and thus not a signatory of the holding company's Annual Report.
18
19
Because these are the only relevant allegations relating to Woolson, he, like
Bushnell, is entitled to dismissal
20
The Fifth Circuit in Tuchman endorsed language from the district court's
opinion in that case rejecting the pursuit of increased compensation as a
sufficient basis for inferring fraud:
On a practical level, were the opposite true, the executives of virtually every
corporation in the United States would be subject to fraud allegations. It does
not follow that because executives have components of their compensation
keyed to performance, one can infer fraudulent intent.
14 F.3d at 1068-69 (quoting 818 F.Supp. 971, 976 (N.D.Tex.1993)).
21
22
We note that the complaint indicates that only one of the three named plaintiffs,
Nishan Serabian, purchased shares during the time period giving rise to the
actionable allegations, and it therefore appears that plaintiffs Horvei and Lo
Priore no longer are proper parties. The district court will need to address this
matter on remand